Macro: Inflation and unemployment

Question 1

What is unemployment and how is it measured?

Answer 1

People that want and are able to work but can’t find a job at the moment

Measured by:

• The claimant count- People who are unemployed and seek benefits, the main one is called “job seekers allowance”
• The labour force survey/international labour organisation measure- Measures all unemployed people whether or not they receive benefits who claim they have been actively seeking work over the past four weeks. Due to the inclusion of the groups below, this measure of unemployment is much higher and is the true measure of unemployment.

People that this will include that the claimant count won’t:

1. People returning to work after a long time as you cant claim benefits after being out of work for over a year or if you rpartner is working
2. Pensioners that don’t want to stop working. Pensioners can’t claim benefits.

Question 2

What is the calculation for unemployment?

Answer 2

(Unemployed / (employment+unemployed))*100

Labour force survey used for international comparisons as countries have different methods of paying benefits.

Question 3

Name 6 causes of unemployment?

Answer 3

• Demand-based unemployment

All below this are called supply-side causes of unemployment:

• Frictional unemployment
• Structural unemployment
• Classical unemployment
• Voluntary unemployment
• Seasonal unemployment

Question 4

What do Keynesians and Monetarists think about unemployment in a recession?

Answer 4

Keynesians think that it could be a long-term problem unless the government does something about it

Monetarists think that it will only be a short-term problem as they believe the economy naturally tends to full employment

Question 5

What is structural unemployment?

Answer 5

People are unemployed because the industry they worked for is in decline or their jobs have been replaced by technology.

This is usually due to either foreign competition or changes in demand.

Question 6

What is frictional unemployment?

Answer 6

People between jobs or looking for a first job. E.g - students finishing university and people made redundant. This type of employment is at a small level but inevitable; it will be short term unless the economy is in recession.

Question 7

What is demand based unemployment?

Answer 7

People aren’t spending enough so businesses have less incentive to take on their staff and because of that, the economy will now operate below its full employment position. This happens when the economy is in recession, unemployment will be very high and will affect most businesses and areas.

Question 8

Explain classical unemployment?

Answer 8

Where high/excessive wages cause unemployment

See graph

The 2 main reasons for this happening are:

1. Government sets minimum wage too high
2. Trade unions are too strong and force wages up above equilibrium

Question 9

What is voluntary unemployment?

Answer 9

People who prefer to live on benefits

Question 10

What is seasonal unemployment?

Answer 10

When workers are only needed at certain times of the year.

E.g-Tourism in hot countries or seaside areas of the UK in winter

This explains why unemployment in the UK fluctuates.

Question 11

Explain 4 costs of unemployment

Answer 11

1. Increased poverty- In the UK benefits are fairly low so most of the unemployed are in “relative poverty”. It also affects the families of the unemployed; this could easily lead to a poverty trap where parents and kids are stuck in poverty as they can’t buy enough resources to help them with their education.
2. Costs to the government- More people on benefits, and less tax (unemployed people don’t pay income tax, they still pay VAT).
3. The cost to the economy- The goods and services they would be producing if they were in work. This can be called the opportunity cost of unemployment and basically, the economy isn’t on the PPF because of it.
4. Social costs- Often linked to increased poverty. Occurs where unemployment is quite high and concentrated among certain groups and in certain areas. It can lead to a number of social problems which cost the government money (external costs) and make everyone’s life more miserable. Such as Increased crime, family breakdown and mental and physical health issues.

Question 12

How might demand based unemployment be reduced?

(policy and evaluation)

Answer 12

Question 13

How could frictional unemployment be reduced?

(policy and evaluation)

Answer 13

Question 14

How could the government reduce structural unemployment?

(policy and evaluation)

Answer 14

Question 15

How might classical unemployment be reduced?

(policy and evaluation)

Answer 15

Question 16

How might voluntary unemployment be reduced?

(policy and evaluation)

Answer 16

Question 17

Define inflation

Answer 17

Refers to how much prices are going up each year on average %terms.

The governments target is 2% + or - 1%

Question 18

What are the two main measures of inflation

Answer 18

C.P.I - Measures increases in the prices of the typical goods and services bought by the average family. E.g- bread but not 1st class flights

R.P.I - The typical goods and services as well as housing costs such as rent and mortgages. R.P.I is usually higher because house prices keep rising.

Question 19

How is inflation measured?

Answer 19

Measured through the use of index numbers. The base year is given a value of 100, if inflation increases the number increases, if it falls the number falls.

Question 20

What is the formula for inflation from price change?

and

How do you work out inflation from index numbers?

Answer 20

See photo

The % change in index number E.g- 100 base year, 105 year 2 = a 5% increase because (5 / 100)*100=5%

Question 21

Explain the main problem with measures of inflation?

Answer 21

Only measures inflation for the average family, doesn’t include people on very high and very low incomes.

There are 2 problems with not measuring very high incomes:

1. They spend a lot of their money on luxuries which aren’t included so we don’t know what happened to those prices
2. They spend a much smaller percentage of their income on food and heating than the average family.

Problems with not measuring the poor:

1. Spend much higher % of income on food and heating

So therefore when prices are going up inflation is a lot worse for poor people. When it comes to inflation each year the government tends to increase them in line with the C.P.I.

Question 22

Briefly, what are the 3 main causes of inflation?

Answer 22

1. Demand-pull inflation
2. Monetarists view of inflation
3. Cost-Push inflation

Question 23

What is demand-pull inflation?

Answer 23

Where people/businesses/government are spending too much money and businesses can’t keep up with the demand, AD is too high, the economy is operating at its full employment position and because of that inflation is going up.

This type of inflation tends to occur when the economy is in a boom and unemployment is fairly low.

Question 24

Why might demand-pull inflation occur (4 reasons)?

Answer 24

1. The government might be spending too much money or deliberately reducing taxes, they might be doing this to try and get unemployment down (too) low or for political popularity reasons.
2. The Bank of England may have reduced interest rates too low which means people are spending too much money. Shouldn’t happen because it’s their job to stop this and control interest rates.
3. If the exchange rate decreases, exports will be cheaper and imports more expensive which will cause inflation and unemployment.
4. Improved business and consumer expectations from previous economic growth might lead to people spending more.

Question 25

What are the Monetarists view’s on inflation?

and

Define money.

Answer 25

Monetarists believe that inflation is always caused by too much money in the economy, hence their name, I.e- excessive growth of the money supply. They believe that this is the root cause of inflation.

Money- Anything you can use to buy goods and services with. Cash is money but in practice in a modern economy like the UK the things that people buy that are the most expensive are bought on credit (the bulk of the money supply consists of credit) I.e-Money people borrow from banks).

Question 26

What is the quantity theory of money?

Long answer,

Answer 26

MV=PT

Monetarists believe that both V and T are relatively stable from year to year. Any increase in the money supply above the extra output is likely to lead to inflation.

They think V is fairly stable because it’s largely linked to what the banks do and the different methods of buying goods and services which doesn’t change much from year to year, therefore V is fairly stable.

They think T is fairly stable because they think the economy naturally tends to full employment which is its maximum output and the only increases will be linked to the underlying improvement in productivity each year at full employment.

Question 27

Explain 2 criticisms of the monetarist theory of inflation.

Answer 27

1. Keynesians don’t believe that V is constant but that it varies with the economy, if the economy is going well people spend money more often. Also if the economy is doing badly, people spend less and the economy slows down.
2. Keynesians don’t accept that the economy always tends to full employment, they would argue that if the economy is in a recession and there was an increase in the money supply then that would possibly lead to an increase in output (T) rather than an increase in inflation.Only is the economy is at full employment would they accept that an increase in the money supply would lead to an increase in inflation.

Question 28

What is cost-push inflation and what are its 4 causes?

Answer 28

Businesses have to put up their prices because their costs are going up. They need to do that to protect their profit.

Can occur if the economy isn’t at full employment.

Causes:

1. Might be an increase in raw material prices, E.g Oil, the more important the material is to production the more price increases by.
2. Increase in wages, could be linked to trade unions or ethics
3. Increase in taxes, on goods particularly (E.g-VAT and specific taxes)
4. A fall in the exchange rate, they have to pay more for goods purchased abroad.

You can show the effects of these by shifting the short-run aggregate supply curve.

Question 29

According to Monetarists, why might the money supply be going up too quickly?

Answer 29

1. The government- They might be spending too much money in relation to the taxes they’re getting. They could also be printing more money instead of borrowing money.
2. The banks are lending out too much money: This could be because of too low interest rates or because banks are taking to many risks, lending out to anyone.

Question 30

Briefly what are 4 costs of inflation?

Answer 30

1. Creates uncertainty
2. Reduces Competitiveness
3. Creates additional costs for businsses and consumers
4. Creates winners and losers

The cost of inflation will tend to be much lower when inflation is very low and stable. That is known as “anticipated inflation”, it’s easier to plan ahead and deal with.

The cost of inflation will tend to be much higher when inflation is higher and unpredictable. This is called “unanticipated inflation.”

Question 31

Why is inflation creating uncertainty bad?

Answer 31

Makes it more difficult for businesses to plan ahead. If they can’t be sure of what prices will be in the future they can’t be sure of what to charge. E.g- the cost of raw materials. Because of that they’re likely to invest less in the future, this will make it harder for the economy to grow in the future.

Question 32

What are the additional costs created for businesses and consumers by inflation?

Answer 32

• Menu costs- The costs to the business of having to keep changing their prices. E.g - Producing new catalogues or changing prices in supermarkets.
• Shoeleather costs- The extra costs for businesses and consumers of taking their time.

Question 33

Why does inflation reduce compeititiveness?

Answer 33

If our prices (our inflation) is/are going up faster than prices abroad, this makes it harder for our businesses to compete. This will make exports more expensive but imports relatively cheaper. This will have a number of negative effects on the economy:

• Will make balance of payments worse
• Increases unemployment (structural)
• If we’re spending a lot more money abroad AD will decrease which will tend to slow down the economy.

Question 34

Who are the winners and losers of inflation?

Answer 34

People who benefit are people who have borrowed money ebcause the money they pay back will be worth less. E.g- The young who ave to borrow money for houses and the government because they have huge debts.

The people who lose out will be savers because the value of their savings will is decreasing over time, E.g- Old and wealthy people.

Question 35

What policies could be used to control demand pull inflation? (and evaluate)

Answer 35

Question 36

What policies could be used to control excessive growth of the money supply? (Evaluate)

Answer 36

Question 37

What policy could be used to control cost push inflation? (Evaluate)

Answer 37

Question 38

What is deflation and why might it happen? (2 main reasons)

Answer 38

Deflation is when on average, prices are going down. When it happens the index will fall.

2 Main reasons why deflation might be happening:

1. Improvements in efficiency, increases in productivity, lower costs, this means on average business can change less
2. People spending less, economy in recession, incomes falling, businesses will find it harder to sell their goods and because of that they’ll reduce their prices. (This is far worse for the economy)

Question 39

Explain 4 negative effects of deflation

Answer 39

1. It has an adverse affect on people’s expectations, this leads to people not spending, AD falls and so the economy is in a worse position. Eg- a consumer might think, if prices are falling now then they’ll continue to fall in the future so I should wait for a lower price.
2. When prices are going down business profits will also tend to fall; because of that businesses invest less, AD decreases and unemployment increases.
3. Increases the value of debt in real terms, making it more expensive to pay it back. This is bad for the government as they have a huge amount of debt.
4. Once the economy is experiencing deflation it is very difficult to turn it around.

Question 40

Why has inflation been low over the past 20-30 years? (4 reasons)

Answer 40

1. The effect of globalisation- We can buy goods a lot cheaper from abroad
2. Trade unions are very weak so it’s harder for them to increase wages, this results in businesses labour costs not increasing which makes it easier to keep prices down.
3. Large scale immigration of workers from Eastern Europe- wages don’t increase as much which helps businesses keep costs down. (Labour supply)
4. Bank of England has been given independent control over the economy, this means that important figures such as interest rates aren’t affected by politics.

Question 41

How do unemployment and inflation relate?

Answer 41

There is an inverse relationship between unemployment and inflation

• The higher unemployment the lower inflation will be
• The lower unemployment the higher inflation will be

This is due to spending and where AD crosses the demand curve.

Question 42

Why does low unemployment lead to inflation? (2 reasons)

and what will be the case if unemployment is too high?

Answer 42

1. Demand pull inflation- People are willing to spend so much money that businesses find it hard to keep up with demand, therefore they tend to increase their prices
2. Cost push inflation- Workers in a more powerful position due to low unemployment, very difficult to attract new staff, this makes wages increase, businesses costs increase and therefore prices increase.

If unemployment is too high, the opposite will be the case, spending will be much lower and wages will no go up very much.

Question 43

What did Phillips do, what does the curve show and what does it look like? (draw)

Answer 43

Phillips plotted the relationship between the level of unemployment and the rate of inflation every year for the uk economy from 1867 to 1961. He found there was a long term stable inverse relationship between the two.

Question 44

What were the 3 basic observations Phillips made?

Answer 44

1. The lower unemployment is the faster inflation increases by
2. No matter how high unemployment is prices will never fall by very much (roughly never more than 1%)
3. The relationship was fairly stable over time

Question 45

Why did Keynesian economics largely welcome the Phillips Curve? (2 reasons)

Answer 45

1. It confirmed the importance of spending in the economy, the higher spending is the lower unemployment would be (except at full employment).
2. Governments face a trade off between unemployment and inflation, you can always reduce one at the expense of the other. Suppose the economy is at Q , high unemployment but no inflation, Keynesian economists believe that you can always reduce unemployment below that by increasing spending as long as the Governmnt is willig to accept higher inflation. Keynesians believe point “a” is stable, it’s up to the Government t dcide whether to have high unemployment and low inflation or the opposite.

ADD GRAPH

Question 46

What are the Monetarists views relating to the Phillips curve?

Answer 46

Monetarists believe that any attempt to reduce unemployment through increasing spending is just going to make inflation worse and have no impact on unemployment in the long run.

For other Monetarist Phillips Curve revision, see notes as they are too long to fit into revision cards.

Question 47

What